Explain why interest rates on short-term commercial paper will be closely tied to the level of the federal funds rate.

Interest rates on short-term commercial paper will be closely tied to the level of the federal funds rate because the federal funds rate influences the cost of money that banks borrow from each other. Commercial paper is typically issued by companies to meet short-term financing needs and is often purchased by banks to meet their reserve requirements. When the federal funds rate increases or decreases, it impacts the overall cost of borrowing and lending money in the economy, which affects the interest rates on commercial paper. As a result, when the federal funds rate increases, the cost of borrowing money for banks goes up, and they pass on this increased cost to companies issuing commercial paper, resulting in higher interest rates. Conversely, if the federal funds rate decreases, the cost of borrowing money for banks goes down, and they offer lower interest rates for companies issuing commercial paper. Therefore, there is a close relationship between the two, and the interest rates on short-term commercial paper will follow the direction of the federal funds rate.